The Bare Minimum

In 2015, Germany introduced a minimum wage of €8.50 an hour, launching a giant field experiment designed to reduce income inequality and poverty. The vision was that every full-time worker should be able to afford a basic standard of living without having to rely on welfare support. New research by Teresa Backhaus and Kai-Uwe Müller scrutinizes the impact of the minimum wage and assesses the extent to which this vision has been made reality.

Using data from the German Socio-Economic Panel (SOEP), the researchers took a longitudinal approach to measure year-to-year changes in hourly wage and disposable income distributions for key groups between 2012 and 2016. They investigated whether the introduction of the minimum wage increased the earnings of those at the bottom of the income distribution scale, if it affected the distribution of disposable incomes, and reduced dependence on welfare and top-up benefits. By simulating models with different levels of minimum wage – such as the €12 an hour minimum called for by Germany’s Social Democrats – they were also able to determine whether a higher minimum wage would be more effective.

The results indicated that a minimum wage is not an effective tool for redistributing income and reducing poverty. Although there was unequivocal evidence of wage increases at the bottom end of hourly wage distribution, these effects were substantially below what would be expected, pointing towards significant non-compliance problems. Yet, a simulated scenario shutting down these problems revealed that the minimum wage alone was not able to help individuals in needy households, even under full-compliance. The introduction of the minimum wage had a negligible impact on welfare dependence, and even saw an increase in disposable household income inequality, driven by the disproportionate growth of higher incomes.

Is the answer to simply increase the minimum wage? The researchers showed that the same problems face a scenario with a markedly higher minimum wage of €12 per hour. The main reason for this is the fact that low wage earners are spread across the distribution of household income, rather than concentrating at the bottom end of the scale. This makes it difficult for the minimum wage to target households that are in need.

The researchers point out the need for improved data and more research on the measurement of hourly wages. They also stress that the minimum wage is not a one-size-fits-all solution. If properly enforced, it may help to foster fair wages, but is of limited help to low-income households, whose problems are far more closely related to employability and job-insecurity than to hourly wage rates.